12.5 Personnel Economics
Congratulations on your promotion! Now you’re the boss. Sure, you’ve worked for bad bosses in the past. But you’ll be different. You’ve just got to figure out how. As the boss, you’ll be in charge of your firm’s personnel policies. Your goal will be to get your workers to do more, without costing your company too much. We’ll explore five big ideas that real-world managers use:
- Ensure your workers have the right skills for the job.
- Motivate your staff with incentives.
- Shape your corporate culture.
- Offer the right benefits package.
- Attract and retain better workers.
As we explore these ideas we’ll discover that economic reasoning can lead to some unexpected insights into how to get your workers to be more effective. Let’s explore each of these big ideas in turn.
Ensure Your Workers Have the Right Skills for the Job
You want to make sure that your workers have the right education and skills for the jobs they do. But how? Should you provide the training yourself, or hire folks who already have the necessary skills? The answer might surprise you: It depends on what type of skills you need.
Investing in general skills might help your workers get better jobs elsewhere.
Most of what you’re learning in college would be categorized as general skills, which means they’re skills that would be useful to many employers. It’s precisely because these skills are portable to other companies that it rarely makes sense for your company to offer general skills training. Why? If you provided your star employees with, say, the skills you learn in an economics class, they could then use those skills to get an even better job at another company. It’s a bad investment because your company would pay the cost of the training, but get none of the benefits.
Investing in job-specific skills helps your workers do a better job for you.
Contrast this with job-specific skills, which are those skills that are only useful in a job with one particular employer. Examples include the skills an economist needs to use their firm’s forecasting model, the skills a factory worker needs to operate the equipment specific to that factory, or the knowledge a human resources manager needs to learn about their company’s employment procedures. Because there’s little chance that you’ll find workers on the outside market who have these exact skills—after all, why would they know these things?—you’ll need to provide this training internally. And because these skills are specific to your company, they’re not going to help your workers find a better job elsewhere.
Motivate Your Workers with Incentives
A key challenge for personnel managers is how to motivate your workers to be on task, rather than spending their day surreptitiously checking social media, gossiping by the water cooler, or slacking off. One way to do this is to provide them with incentives to make the right choices. This is the cost-benefit principle at work: Tweak the costs and benefits your staff face so that the best choice for your company also becomes their best choice.
Offer better pay for better performance.
If you simply offer your workers a weekly wage—which they get paid no matter how much work they get done—do they really have an incentive to work hard? If they’re not self-motivated, probably not. Pretty soon they’ll realize they’ll get paid whether or not they work hard. Instead, you can offer a pay-for-performance plan, linking each worker’s income to their performance on the job.
Your goal should be to align your workers’ incentives with those of your business. There are lots of ways to do this. In sales jobs, it’s common to supplement a relatively low base wage with a healthy commission, which is a share of the total sales each worker makes. This gives your workers an incentive to keep making sales, rather than slacking off. Or perhaps you can pay your workers a piece rate, which is where you pay workers only for what they actually do—paying them per piece produced—rather than just paying them for turning up. For instance, instead of paying glass installers a fixed hourly wage, the Safelite AutoGlass company shifted to paying them a fixed amount for each window they installed. This increased the incentive for workers to focus on the task at hand, and the number of windows each worker installed rose by 44%!
Want that windshield fixed quicker? Pay him per windshield, rather than per hour.
If a piece rate isn’t feasible—perhaps because you can’t objectively measure what each employee produces—then you can use bonuses to provide incentives. For instance, many financial firms offer their young analysts relatively low base pay, but also the prospect of earning an annual bonus of tens—and sometimes hundreds—of thousands of dollars if they earn strong evaluations. No wonder they work so hard!
There’s another more subtle way to provide incentives to your workers: Offer them a clearly defined career path, and combine this with a culture of always promoting your high-performing workers. Then the incentive for working hard isn’t a commission, piece rate, or bonus, but rather a promotion and a pay raise.
Reward good decisions, not just hard work.
Most senior managers already work long hours, but they might slack off in a different sense. Managers can be tempted to make decisions that make them popular (Pay raises for everyone! Free food! Casual Fridays!), rather than making the tough decisions that will increase your company’s profits. By offering your senior managers a financial slice of the business—that is, by giving them stock in your company—you give them a personal incentive to make those tough decisions that’ll boost your business’s bottom line. Some companies also offer stock options, which are financial instruments that provide a big payoff for managers who can raise their firm’s stock price.
Incentives can involve both carrots and sticks.
You can motivate your workers with either carrots or sticks.
You can provide your workers with incentives either by rewarding their good performance (giving “carrots”), or by punishing their poor performance (using the “stick”). So far, we’ve focused on the carrots. But there’s also a very important stick that keeps workers focused: the threat of being fired. When Jack Welch was CEO of General Electric, he would fire the bottom 10% of his employees each year, which kept them on their toes.
Short-sighted managers sometimes believe that it’s cheaper to use sticks than to use carrots. They argue that sticks don’t cost anything, while carrots can be expensive. But this argument forgets that workers also have options. Remember: In order to attract good workers, the whole pay package that you offer—the base pay, plus the benefit of the carrots you offer, less the cost of the sticks—must be at least as attractive as what they could earn in other jobs. If not, your best workers will just go elsewhere. So if you use sticks to motivate workers, you’re going to have to make it up to them by either topping up their base pay or offering more carrots. General Electric used more carrots, and the top 20% of their workers each year were rewarded with company stock as a bonus.
But be wary: Incentives can distort effort.
Okay, so far so good. What’s the drawback with using incentives? The problem is simple: You get what you pay for. Usually, that’s a good thing. But it can be a problem if what you pay for isn’t exactly what you want.
Over recent years, governments have increased the incentive for teachers to do a better job. These policies typically threaten to close schools if their students perform poorly on standardized tests. This provides strong incentives for teachers to raise the average grades of their students on standardized tests. But this doesn’t necessarily translate into better teaching. Some schools responded by cutting recess, social studies, or any subject that isn’t tested. Some teachers focused more on “teaching to the test,” rather than true student learning. Other schools tried to raise test scores by expelling bad students, reclassifying some kids as learning disabled so they’re not counted in the school’s average, or encouraging weak pupils to stay home on test day. Some teachers have even been caught cheating, erasing their students’ wrong answers and filling in the correct bubbles instead.
Similar problems arise in a corporate world, too, a lesson that Wells Fargo discovered the hard way. The bank offered its staff financial incentives for signing up new accounts. Instead of persuading new customers to sign up for new accounts, thousands of staff members got to work creating more than 3 million fake accounts for existing customers. Eventually they were caught, and Wells Fargo was forced to pay millions of dollars in fines.
Bottom line: When “what you pay for” differs a lot from “what you want,” strong incentives can be a real problem. The problem is that workers will do more of what you pay for, but less of the other stuff you may want.
Shape Your Corporate Culture
Economic thinking about financial incentives is useful for appealing to extrinsic motivation of your workers—motivating them to gain external rewards, such as higher pay. But psychologists have also documented the importance of intrinsic motivation, which is the desire to do something for internal reasons, such as the enjoyment and pride you get from doing a good job. For instance, millions of people donate blood to local blood banks. They’re not doing it for the free donut, but because they believe it’s the right thing to do. Likewise, your company’s corporate culture can be a powerful way to harness intrinsic motivation. A business that lives up to a core set of ideals that workers identify with will be rewarded with a workforce who work hard, help each other out, and try to help the company succeed. When people believe in what they’re doing, they do it better.
Thinking about the values your workers hold can be helpful here. Many workers have a sense of reciprocity, and when they feel that they’re treated well, they’re more likely to treat your business well in return by working hard. Thus, paying your staff higher wages can lead them to be more productive as they work hard to return the favor. Fairness also really matters, because workers tend to slack off when they feel they’re being treated unfairly. To avoid this, your personnel policy should include clear and transparent procedures for promotions and pay raises. And people like to feel valued. Remember, praise is free, but it helps boosts your workers’ morale and hence their productivity.
Your corporate culture also shapes interactions between your workers. One careful study showed that supermarket cashiers are more productive when they’re working the same shift as other highly productive cashiers. Why? When you care about what your co-workers think of you, you have a greater incentive to work hard.
EVERYDAY Economics
Why charitable work is unpaid
Poorly designed incentives can undermine intrinsic motivation. In one famous experiment, high school students were recruited to collect charitable donations. One group was given a speech reminding them of the good they were doing, which activated their intrinsic motivation. The second group was also paid an incentive of 1% of the amount collected, which activated their extrinsic motivation. Despite these stronger incentives, this second group actually collected less. The lesson of this experiment is that sometimes intrinsic motivation really is the best incentive, and appealing to financial motives can reduce intrinsic motivation.
Offer the Right Benefits
Your ability to attract top-notch staff to your company depends on the entire compensation package that you offer—including not only the annual salary but also the benefits you offer. That’s why it’s important to offer the right set of benefits. Generally speaking, workers prefer extra wages to extra benefits—after all, they can always use those extra wages to buy extra benefits. But sometimes there are good reasons to offer benefits rather than more cash. Let’s explore.
Some benefits aren’t taxed.
Many employee benefits are subject to lower taxes than wages are. For instance, there are tax breaks for contributing to your staff’s retirement savings and health insurance premiums and for setting up plans that allow them to use pre-tax dollars for retirement savings, health care, child care, and even parking. These tax breaks mean that you can provide many benefits for your workers more cheaply than they can provide them for themselves.
Even when there aren’t specific tax breaks, it often makes sense to offer fringe benefits. After all, it’s cheaper to buy your workers a coffee than it is to pay them more income, let them pay tax on that income, and have them buy their own coffee with what remains. This is part of the reason why technology companies like Google and Facebook provide free snacks to their employees. But the IRS has figured out that fringe benefits are a popular way to avoid taxes; it has worked to limit the benefits that are tax-exempt and recently raised taxes on free snacks for workers.
Employers have purchasing power.
There’s another reason that many companies offer health insurance—they tend to get a better deal than their workers do on their own. Why? Health insurance companies are worried that people who are sick are the most likely to buy health insurance. As such, if you try to buy health insurance on your own, they’ll think it’s likely that you are sick, and so they’ll charge you a high price. But if you buy a policy for your entire workforce, it’s a different matter, because it’s unlikely that all your staff are sick. Consequently, it’s cheaper to buy health insurance for all of your workers than for each of them to buy it on their own.
Complements can help, substitutes can hurt.
You might think that this heading says, “Compliments can help”—that you should be nice to your workers. You should. But economists also think about complements (with an e), which are things that go well together. In particular, you should provide complements to hard work as a way of nudging your workers toward being more productive. For instance, my workplace offers free coffee all day, hoping it will keep me alert. Cisco buys its workers laptops rather than cheaper desktop computers, hoping that its staff will take their work home with them over the weekend. Managers of the outdoor store REI provide up to $300 of free gear to their workers. Why? They figure that their staff will come to know the gear, which makes them better salespeople. The software firm SAS offers on-site health care, car cleaning, and a beauty salon, all of which give their employees fewer reasons to be out of the office. And the regional supermarket chain Wegmans offers flu shots to all workers, which reduces the number of sick days. Each of these benefits is a complement to hard work.
You should also make sure to minimize the substitutes for hard work. So while free coffee is a good idea, free Sleepy Time tea isn’t. A comfortable office chair is a great idea, but avoid couches that can be used for afternoon naps. Have you noticed that hardly any office buildings have a covered, nice outdoor area for smokers? It’s because they’re trying to discourage unproductive cigarette breaks.
Attract the Best Workers
Whenever you think about your personnel policies, you should also think about how they’ll affect the types of workers you can attract and retain. For instance, if you offer your workers strong incentives for good performance, then your firm will be more attractive to folks who are high performers, and less attractive for those who would prefer to slack off. And this can be a big deal. Recall the 44% gain in productivity at Safelite AutoGlass? Around half of that was due to the fact that the piece rate helped it attract and retain better workers. Likewise, you’ll discover an additional benefit of offering training to your employees. It doesn’t just make your workers more productive, it also attracts a specific type of worker to your company—those who are motivated to learn new things and who want to advance in their field.
More generally, as you think about what benefits your company should offer, think about how they’ll affect which workers you’ll attract and retain. For instance, providing a gym will attract fitness fanatics, offering health insurance will attract older workers, and giving workers the flexibility to work from home will help attract parents.